MACAU: TAKEAWAYS FROM MACAU VISIT

Following two days of meetings in Macau, we are reiterating our negative thesis on the Macau stocks. December could mark the low in investor sentiment but any recovery continues to look further and further away. I was hoping for the emergence of a catalyst and/or signs of a fundamental bottom. Alas, I was disappointed.

McCullough: I’ve Never Tried Heroin and Europe Looks Like Hell

In this excerpt from today’s Morning Macro Call for institutional subscribers, Hedgeye CEO Keith McCullough discusses the recent moves in European equities and questions whether ECB President Mario Draghi’s money printing (which we affectionately call the “Draghi Drugs”) can still deliver a high. If you’re hedged on the hope that central banks will save you, the fundamental issues in the major economies will hurt you.

Keith's Macro Notebook 12/17: Yen | Oil | UST10YR

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THE HEDGEYE MACRO PLAYBOOK

Takeaway:In today's edition of the Macro Playbook, we contextualize the broad-based de-risking of the HY credit asset class.

INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

Consumer Staples Select Sector SPDR Fund (XLP)

Health Care Select Sector SPDR Fund (XLV)

iShares National AMT-Free Muni Bond ETF (MUB)

Vanguard Extended Duration Treasury ETF (EDV)

iShares 20+ Year Treasury Bond ETF (TLT)

Short Ideas/Underweight Recommendations

SPDR S&P Regional Banking ETF (KRE)

iShares Russell 2000 ETF (IWM)

iShares MSCI European Monetary Union ETF (EZU)

iShares MSCI France ETF (EWQ)

SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

QUANT SIGNALS & RESEARCH CONTEXT

Illiquidity Risk Remains in the Junk Bond Market: Consistent with our #Quad4 and #Bubbles themes – which calls for an allocation to relative safety over high yield/junk in the domestic fixed income market – spreads continue to widen in the corporate bond space.

On a WoW basis, OAS on HY USD bonds backed up +19bps yesterday and are now +80bps WoW and +150bps MoM to cycle-wides of 603bps. Obviously, as we have detailed extensively, the energy sector continues to lead declines in the HY USD bond market. Specifically, OAS in this space backed up +23bps yesterday and are now +155bps WoW and +397bps MoM.

Source: Bloomberg L.P.

Not surprisingly, given the dour state of secondary bond market liquidity, emerging market USD debt is selling off as well, with OAS having backed up +81bps WoW and +142bps MoM to cycle-wides of 483bps.

Source: Bloomberg L.P.

In the following two charts, which we have sourced from our presentation on Emerging Markets yesterday (email to obtain the replay), we detail the state of secondary bond market liquidity in the U.S. and specifically as it pertains to EM debt. Needless to say, there is a pervasive lack of liquidity in these asset classes and the crowded nature of these trades amid an era of ZIRP dramatically amplifies the risk of what we have seen thus far – i.e. reflexive selling.

All told, we continue to think this negative re-rating for HY and EM USD debt is likely to have a substantial impact on broader “risk assets” to the extent the broad-base de-risking of this asset class continues.

#Quad4(introduced 10/2/14): Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.

#Bubbles(introduced 10/2/14): The current economic cycle is cresting and the confluence of policy-induced yield-chasing and late-cycle speculation is inflating spread risk across asset classes. The clock is ticking on the value proposition of the latest policy to inflate as the prices many investors are paying for financial assets is significantly higher than the value they are receiving in return.

The securities highlighted above represent our top ten investment recommendations based on our active macro themes, which themselves stem from our proprietary four-quadrant Growth/Inflation/Policy (GIP) framework. The securities are ranked according to our calculus of the immediate-term risk/reward of going long or short at the prior closing price, which itself is based on our proprietary analysis of price, volume and volatility trends.

Effectively, it is a dynamic ranking of the order in which we’d buy or sell the securities today – keeping in mind that we have equal conviction in each security from an intermediate-term absolute return perspective.

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12/17/14 08:25 AM EST

Will The Fed Centrally Plan a Bounce?

Client Talking Points

YEN

We re-entered the dark side with a SELL signal on green yesterday (see Real Time Alerts product) and, barring Janet going completely dovish today, we think there’s immediate-term downside (vs. USD) in Burning Yens to $121.78; that would be good for the Nikkei, which held @Hedgeye TREND support of 16,441 overnight.

OIL

Oil saw another bounce (yesterday)… and another selloff this morning (-1.8% WTI to 54.93 with no support to 52.83) – this is what we call pervasive #deflation expectations being baked into one of the most epic perpetual inflation expectations in world history. Respect its longer-term ramifications.

UST 10YR

The UST 10YR Yield touched 2.03% yesterday, then bounced to 2.10% and that puts is right in the middle of our 2.03-2.19% immediate-term risk range ahead of the Fed. We have no idea what these people are going to do, but if they did remove “considerable time” and the Long Bond got hit on that, we would buy more of our best Macro Long Idea (TLT).

Asset Allocation

CASH

61%

US EQUITIES

3%

INTL EQUITIES

0%

COMMODITIES

0%

FIXED INCOME

30%

INTL CURRENCIES

6%

Top Long Ideas

Company

Ticker

Sector

Duration

EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).

XLP

The U.S. is in Quad #4 on our GIP (Growth/Inflation/Policy) model, which suggests that both economic growth and reported inflation are slowing domestically. As far as the eye can see in a falling interest rate environment, we think you should increase your exposure to slow-growth, yield-chasing trade and remain long of defensive assets like long-term treasuries and Consumer Staples (XLP) – which work decidedly better than Utilities in Quad #4. Consumer Staples is as good as any place to hide as the world clamors for low-beta-big-cap-liquidity.

Three for the Road

TWEET OF THE DAY

RUSSIA: +5.3% on the "bounce" to -52.4% YTD (math: you'd have to be +108%, from here, to get back to breakeven) #crash

@KeithMcCullough

QUOTE OF THE DAY

Leadership and learning are indispensable to each other.

- John F. Kennedy

STAT OF THE DAY

The Russian Central bank has spent approximately $80-$100 Billion on FX interventions to strengthen the Ruble – but yet to no avail. The FX reserve is now at a 5 year low.

12/17/14 08:21 AM EST

CHART OF THE DAY: Emerging Markets Are More Important Than You Might Think

This idea of "emerging economies" is a bit of a misnomer. According to our analysis, on a purchasing parity basis the so called emerging economies comprised 56% of global GDP share in 2013. Moreover, in the same year emerging economies comprised 73% of global growth. So as emerging markets go, so to goes global economic growth.

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